Mitek Systems: An Undervalued Player In Identity Verification Market

The want for safe and dependable id verification options has change into paramount in immediately’s digital age. With the fast rise of on-line transactions, digital providers and distant interactions, the significance of verifying the identities of people and entities has elevated considerably for the safety of shoppers and companies alike. Traditional identification strategies, corresponding to bodily IDs or paperwork, are prone to fraud, impersonation and knowledge breaches. As a end result, there was a rising demand for digital id verification options that leverage superior applied sciences corresponding to biometrics, synthetic intelligence [AI], and blockchain to make sure the authenticity and integrity of identities within the digital realm. These options provide enhanced safety, comfort, and compliance with regulatory necessities, making them indispensable for varied industries. Mitek Systems (NASDAQ:MITK) is a pacesetter on this business and is positioned effectively. Over the final decade, the efficiency has been underwhelming, with a complete return of 113% in comparison with 212% for the S&P 500. The state of affairs regarded completely different till the tech bubble collapsed on the finish of 2021 when Mitek posted peak complete returns of 450%. Let’s see if Mitek is now a pretty alternative.

Identity Verification is a development market

I aforementioned why the market is enticing within the introduction and the market is anticipated to develop at a quick clip. According to Markets and Markets, it’s projected to succeed in a $15.8 billion measurement by 2025, a 15.6% CAGR, fueled by its growing relevance all through giant verticals like Financial Services, Telecom or Insurance.

From a private expertise, over the previous few years, I noticed this modification in additional superior verification necessities on web sites and providers. As the web matures additional and firms attempt to scale back fraud, the necessity for these options will enhance. Government laws are one other tailwind. In Germany, for instance, if you wish to open a brokerage account, it’s essential to confirm your id. This was completed over the submit by mailing a replica of your passport and having round 3-8 weeks of processing time. This similar course of now takes about 5-Quarter-hour through digital options.

The business is continually battling unhealthy actors who attempt to devise new methods to trick the system. This implies that steady funding in growing the options additional is required, nevertheless it additionally allows continued new product releases or updates. Mitek’s aggressive benefit is its knowledge flywheel: More knowledge influx permits higher and quicker studying of the algorithms, enabling higher adoption and retention of shoppers, resulting in extra person knowledge inflows.

Steady Revenue development

Over the final 5 years, Mitek noticed regular income development, averaging round 15% per yr. While that is spectacular, EPS (27% CAGR) and Free money move per share (45% CAGR) grew a lot quicker and extra unstable.

This discrepancy was as a consequence of important working leverage: While gross margins stayed within the excessive 80s and solely barely improved (to be truthful, there may be not a lot to optimize at an 85% gross margin), SG&A margin declined from 60% to 42% and all profitability metrics improved considerably. EBIT margin grew from barely worthwhile (2%) to 22% and EBITDA elevated to 31%. These enticing software program margins might see additional upside alongside the best way.

An enhancing Capital Return Profile

Mitek matured fairly a bit as an organization over the past 5 years. We can see that the corporate regularly diluted shareholders whereas margins had been low. This led to a 28% dilution over the interval, however we will additionally see that in early 2022 the corporate began repurchasing shares and retaining the share depend flat. This timing is in step with the collapse of the tech bubble and reveals cheap capital allocation from administration: Dilute whereas stock is an affordable currency, repurchase it as soon as it’s a good worth. We can even see that Mitek made a big acquisition in early 2022 in a $126 million all-cash deal: Mitek bought HooYu, a number one KYC (know your buyer) agency from the UK, to enhance its portfolio. At the time of the deal, Mitek had a market cap of round $600 million, which was 1/5 of the corporate. This deal was financed primarily by taking up debt, as proven in Net Debt Issued.

A compelling Valuation

Over the final decade, Mitek hasn’t been a wonderful stock to personal. After the stock tripled following the covid lows, we have seen a major 61% drawdown, bringing the stock all the way down to ranges final seen pre-pandemic. The stock trades at an affordable a number of of 10 instances ahead EBITDA in comparison with the median of 17 instances and trades at a 5.8% FCF yield. Let’s look into the stock additional with an inverse DCF mannequin.

Frequent readers of my analysis will discover that I adjusted my inverse DCF fashions a bit: I focus extra on Owner Earnings now, which I outline as:

FCF + Growth CapEx – SBC +/- Net working capital adjustments

I consider that this method is extra correct than utilizing simply free money move for a number of causes:

1. Stock-based compensation is an actual expense and must be accounted for.
2. Growth CapEx could possibly be returned to house owners as a substitute.
3. NWC Changes can skew FCF within the brief time period and must be adjusted.

Using this framework, we will see that Mitek may be very attractively priced and doesn’t require a variety of development to challenge above-market returns, particularly if we think about the projected market development price of 15% for id verification options.

The largest threat I see looming over the stock are continued authorized issues with USAA (United Services Automobile Association) relating to patent infringements. The issues have been occurring for some time (see this press release from Mitek in 2014). In May 2022 Mitek gained the newest spherical in a patent struggle relating to Mitek’s cellular banking answer.

Mitek seems like a compelling funding at these ranges and I’m contemplating opening a place.